Sunday, April 09, 2006

Costs Hit Close to Home

Canadians spent a higher portion of their income on housing in the fourth quarter, as high home prices and utility costs pushed affordability to its worst level in a decade, said a report by the Royal Bank of Canada.

That deterioration is coming at the end of 10 years of generally "excellent" affordability conditions, the report by the bank's economics department noted.

While affordability will likely continue to slide in the first half of the year, rising incomes and steady interest rates and house prices should stop the declines in 2007, economists said.

RBC Financial Group's latest housing affordability index measures the proportion of pre-tax household income needed to service the costs of owning a home.

The worst-hit cities were Vancouver and Calgary, where house prices escalated rapidly. Royal Bank expects the pace of demand for new and existing homes in the rest of the country to slow moderately over the next two years because of the decline in affordability.

Much of the drop in affordability stems from slower growth in household income, said Derek Holt, the Royal Bank's assistant chief economist. "This was unable to offset increases in mortgage rates, house prices and utilities costs," he said.

Benjamin Tal, senior economist at CIBC World Markets, expects affordability to get worse before getting better.

"Income growth in Canada is starting to accelerate, wages are rising," Tal said. "But the increase in house prices has been faster. Add to it higher interest rates, and the overall size of mortgages is rising, so affordability is going down."

RISING INTEREST RATES

The impact of rising rates has been more pronounced, Tal said, because about 22% of mortgages are variable-rate.

"With interest rates rising by maybe another (quarter to half point), we probably will see affordability continue to deteriorate, at least for the next few months," he said.

Beyond that, he expects it to stabilize because interest rates will stop rising, house prices will level off, and Tal predicts incomes will be stronger than expected.

"So, I think affordability will not be much worse a year from now. It might even be better."

The report suggests that condominiums were the most affordable Canadian housing type during the fourth quarter, with an index of 25.7%. A standard townhouse is next at 30.1%, followed by a detached bungalow at 37%. A two-storey home remains the least affordable type, with an index reading of 43%.